Friday, August 19, 2016

Sometimes after retirement,
central bankers become surprisingly candid about the economy, their role in the
economy and the Federal Reserve's role in how the economy functions. In
that light, here is a link to an interview on CNBC's
Squawk Box with Richard Fisher, former President of the Dallas Federal Reserve
Bank back in early January 2016 discussing the impact of China's economic
slowdown on the U.S. stock market. To help you digest this fascinating and
surprisingly candid interview, I've posted a transcript of the interview below
the video:

"Richard
Fisher: What the Fed did, and I was part of that
group, we front-loaded a tremendous market rally starting in March of
2009. It was sort of a reverse Wimpy factor. Give me two hamburgers today for
one tomorrow. We had a tremendous rally and I think there's a great digestive
period that's likely to take place now. And it may continue. Once again, we
front-loaded, at the Federal Reserve, an enormous rally in order to accomplish a
wealth effect. I would not blame this [the 2016 selloff] on China. We are
always looking for excuses. China is going through a transition that will take
a while to correct itself. But what's news there? There's no news there.

Squawk Box: I guess the question
Richard is: How ugly will it get? If you do see this big unwind of Fed Policy
which fueled a 6 and one-half year bull market, what does it look like on the
way down?

Richard Fisher: Well, I
was warning my colleagues, don't go [inaudible] if we have a 10-20% correction
at some point. These markets are heavily priced. They are trading at 19
and a half time earnings without having top line growth you would like to have.
We are late in the cycle. These are richly priced. They are not cheap. I could
see a significant downside. I could also see a flat market for quite some
time, digesting that enormous return the Fed engineered for six years.

Squawk Box: Richard, this digestive
period, does it usher in an era where assets can't perform in the absence of
accommodation?

Richard Fisher: Well,
first of all, I don't think there can be much more accommodation. The
Federal Reserve is a giant weapon that has no ammunition left. What I do worry
about is: It was the Fed, the Fed, the Fed, the Fed for half of my tenure
there, which is a decade. Everybody was looking for the Fed to float all boats.
In my opinion, they got lazy. Now we go back to fundamental analysis, the kind
of work that used to be done, analyzing whether or not a company truly on its
own, going to grow its bottom line and be priced accordingly, not expect the
Fed tide to lift all boats. When the tide recedes we're going to see who's
wearing a bathing suit and who's not. We are beginning to see that. You saw
that in junk last year. You also saw it even in the midcaps, and the S&P
stripped of its dividends. The only asset that really returned anything last
year, again if you take away dividends, believe it or not, was cash at 0.1%.
That's a very unusual circumstance.

Squawk Box: Richard. This has been
an absolutely extraordinary interview. For you to come on here and say "I
was one of the central bankers who engineered the frontloading of the banks, we
did it to create a wealth effect" and then you go on and tell us, with a
big smile on your face that we are overpriced, which is the word that you used,
and there would be some digestive problems, are you going to take the rap
if there is a serious correction in this market? Will you equally come on and
say "I'm really sorry we overinflated the market", which is a logical
conclusion from what you've said so far in this interview.

Richard Fisher: First of
all I wouldn't say that. I voted against QE 3. But there's a reason for doing
this. Let's be fair to the central banks. We had a horrible crisis. We had to
pull it out. All of us unanimously supported that initial move under Ben
Bernanke. But in my opinion we went one step too far, which is QE3. By
March 2009 we had already bought a trillion dollars of securities and the
market turned that week. To me, personally, as a member of the FOMC, that was
sufficient. We had launched a rocket. And yet we piled on with QE 3, but
the majority understandably worried we might slide backwards. I think you have
to be careful here and frank about what drove the markets. Look at all the
interviews over the last many years since we started the QE program. It was
the Fed, the Fed, the Fed, the European central bank, the Japanese central
bank, and what are the Chinese doing? All quantitative easing driven by
central bank activity. That's not the way markets should be working. They
should be working on their own animal spirits, but they were juiced up by the
central banks, including the Federal Reserve, even as some of us would not
support QE 3." (all bolds are mine)

As an aside, note that how, like Pontius Pilate
of old, he washes his hands of any responsibility for the implementation
of QE 3, the Fed's dying gasp at propping up the American/global economy.

Let's look at the key
takeaway. During the late stages of the Great Recession when it
looked like the global economy might collapse on itself, Mr. Fisher admits
that the Federal Reserve deliberately sponsored a stock market rally (i.e.
created a bubble) to create a wealth effect to lure American consumers to
spend and stimulate the moribund economy back to life. At the time of the
interview, Richard Fisher noted that stocks were "heavily
priced", trading at 19.5 times earnings. According
to Robert Shiller,'s CAPE Ratio, here's what stock market valuations
look like now:

Let's focus on the period from the beginning of 2007 to the present (July 2016):

The CAPE Ratio or
Cyclically Adjusted Price-Earnings ratio which is also known as the P/E 10
ratio is defined as the price of stocks (or the stock market as a whole)
divided by the moving average of ten years of earnings adjusted for inflation.
Higher than average CAPE Ratios suggest that there will be lower than
average long-term annual returns and lower than average CAPE Ratios suggest
that there will be higher than average long-term annual returns on stocks.
As of July 2016, the CAPE Ratio was sitting at 26.2, in the neighbourhood of
its highest level since the end of the Great Recession when the CAPE Ratio fell
to a low of 13.32 in March 2009. Over the past 134 years, the CAPE Ratio
has averaged 16.6; the value for July 2016 suggest that the market is
significantly overpriced. Thanks to Richard Fisher's candidness, we now
know exactly why; the Federal Reserve deliberately took action to front-load a market rally in March 2009 when, coincidentally, the CAPE Ratio was at
its lowest point since 1987.

I find it particularly
interesting that a central banker is candid enough to admit that this entire
post-Great Recession recovery has been engineered by the extraordinary
interventions of the Federal Reserve and their fellow central banks in
Japan and Europe and that, by Mr. Fisher's own admission, the Fed has no monetary ammunition left. The
broader stock market has risen based solely on monetary policy, not on
fundamentals like growing profitability, controlled debt levels and improving
total factor productivity. As Mr. Fisher notes, the Fed "floated all
boats" and, when the "tide recedes, we're gong to see who's wearing a
bathing suit and who's not.".

Unfortunately,
he suffered from a lack of foresight when he voted in favour of both QE 1
and QE 2, the unconventional central bank actions that started us down this
very dangerous path.

1 comment:

Thanks for a great article, I'm also surprised he was so candid. The real economy exist somewhere far from Wall Street and can be seen in parts of America where most of us live. After eight long years of near or zero interest rates, massive government deficits, and watching tons of money and stimulus being poured into the economy we remain mired in slow growth.

In the end our future has a way of being tied to reality and certain economic laws as well as laws of nature that hope and delusion cannot defy. While these bonds can be ignored for a time the force they have over us at some point will suddenly pull us crashing to the ground. The article below delves into why the FED has not put us on the right path.

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About Me

I have been an avid follower of the world's political and economic scene since the great gold rush of 1979 - 1980 when it seemed that the world's economic system was on the verge of collapse. I am most concerned about the mounting level of government debt and the lack of political will to solve the problem. Actions need to be taken sooner rather than later when demographic issues will make solutions far more difficult. As a geoscientist, I am also concerned about the world's energy future; as we reach peak cheap oil, we need to find viable long-term solutions to what will ultimately become a supply-demand imbalance.